EXCHANGE 


UNIVERSITY  OF  PENNSYLVANIA 


STATE  REGULATION  OF  THE   SECURI 

TIES  OF  RAILROADS  AND  PUBLIC 

SERVICE  COMPANIES 


BY 

MARY  L.  BARRON 


A  THESIS 

PRESENTED    TO    THE    FACULTY    OF    THE    GRADUATE    SCHOOL    IN 

PARTIAL    FULFILLMENT    OF    THE    REQUIREMENTS    FOR 

THE    DEGREE    OF    DOCTOR    OF    PHILOSOPHY 


Reprinted  from  Vol.  LXXVI  of  THE  ANNALS  of  the 

AMERICAN  ACADEMY  OF  POLITICAL  AND  SOCIAL  SCIENCE 

Philadelphia,  March,  1918 


UNIVERSITY  OF  PENNSYLVANIA 


STATE  REGULATION  OF  THE   SECURI 

TIES  OF  RAILROADS  AND  PUBLIC 

SERVICE  COMPANIES 


BY 

MARY  L.  BARRON 


A  THESIS 

PRESENTED    TO    THE    FACULTY    OF    THE    GRADUATE    SCHOOL    IN 

PARTIAL    FULFILLMENT    OF    THE    REQUIREMENTS    FOR 

THE    DEGREE    OF    DOCTOR    OF    PHILOSOPHY 


Reprinted  from  Vol.  LXXVI  of  THE  ANNALS  of  the 

AMERICAN  ACADEMY  OF  POLITICAL  AND  SOCIAL  SCIENCE 

Philadelphia,  March,  1918 


u 


CONTENTS 

PAGE 

Part  I.     Powers  and  procedure  of  the  public  service  commissions  in  relation 

to  security  issues  of  public  service  corporations 5 

1.  Powers  of  public  service  commissions 5 

2.  Procedure 6  S 

Part  II.    State  statutory  limitations  on  the  issue  of  securities 11 

1.  Security  issues  defined 11  S 

2.  Limitations  on  the  proportion  between  stocks  and  bonds. . ...  14  •/" 

3.  Legitimate  purposes  for  which  securities  may  be  issued 16  *' 

4.  Limitations  on  scrip  dividends 19 

5.  Form  of  payment  for  securities  prescribed 21 

6.  Limitations  on  the  par  and  selling  price 23 

Part  III.  Summary  and  conclusion 25 


380108 


STATE    REGULATION    OF    THE    SECURITIES    OF 

RAILROADS  AND  PUBLIC  SERVICE 

COMPANIES1 


POWERS  AND  PROCEDURE  OF  PUBLIC  SERVICE  COMMISSIONS  IN 

RELATION  TO  SECURITY  ISSUES  OF  PUBLIC  SERVICE 

CORPORATIONS 

State  control  of  the  security  issues  of  public  service  corporations 
has  grown  by  slow  stages  from  an  almost  complete  absence  of  any 
checks  in  the  era  of  special  charters  to  the  recent  concentration,  in  a 
few  states,  of  absolute  power  in  the  hands  of  a  commission.  The 
present  state  laws  governing  a  public  utility's  security  issues  are  to 
be  found  in  a  few  special  charter  acts,  in  general  statutes,  and  in 
special  public  service  commission  acts.  As  the  latter  represents  the 
most  complete  method  of  supervision,  particular  emphasis  is  placed 
on  the  analysis  of  this  group. 

In  answer  to  a  deeply  felt  need  of  an  administrative  body  to 
enforce  the  general  laws  in  regard  to  railroads  and  public  utility 
corporations,  public  service  commissions  have  become  so  widely 
established  that  in  1917  there  is  only  one  state  which  has  no  kind  of 
public  utility  commission — Delaware.  Twenty-four  states,  how- 
ever, have  failed  to  confer  on  their  commissions  power  to  regulate 
the  issuance  of  securities.2  Commission  control  of  securities  is, 
therefore,  absent  from  twenty-five  states. 

All  degrees  of  power  from  publicity  to  absolute  control  have 

1  No  secondary  material  has  been  used  in  the  preparation  of  this  article.    The 
Public  Service  Commission  Act  (summarized  in  Table  I)  and  the  codified  laws 
(Table  II)  of  each  state  have  been  analyzed  to  discover  in  what  manner  the 
security  issues  of  railroads  and  of  public  service  companies  have  been  subjected  to 
regulation.     Since  the  tables  have  been  arranged  so  that  the  exact  citation  for  any 
subject  is  easily  found,  footnote  references  have  been  omitted  when  a  statute  is 
analyzed  in  the  text. 

2  Alabama,  Arkansas,  Colorado,  Connecticut,  Florida,  Idaho,  Iowa,  Kentucky, 
Louisiana,   Minnesota,    Mississippi,   Montana,   Nevada,    New   Mexico,   North 
Carolina,  North  Dakota,  Oklahoma,  Oregon,  South  Carolina,  South  Dakota, 

Utah,  Washington,  Wyoming. 
5 


6  POWERS  AND  PROCEDURE 

been  conferred  over  securities  on  the  remaining  commissions. 
Rhode  Island's  one-paragraph  provision  covers  only  the  stock,  and 
not  the  bond,  issues  of  street  railways.  The  powers  and  the  work  of 
this  commission  in  the  matter  of  securities  are  so  slight  as  to  amount 
to  non-regulation.  The  Pennsylvania  and  Virginia  commissions 
are  of  the  pure  publicity  type,  their  work  consisting  of  the  filing  of 
notices  of  increases  of  securities.  There  are  ten  commissions  that 
are  limited  to  inquiring  into  the  truth  of  the  statements  in  the  corpo- 
ration's application  for  approval.3  Texas  has  a  very  stringent  law, 
but  one  that  is  enforced  not  so  much  through  the  powers  conferred 
directly  on  the  commission  as  through  the  severity  of  the  penalties 
imposed  upon  the  corporation  for  any  infringement. 

Some  initiative  is  permitted  all  the  other  commissions  by 
statute.  Besides  determining  the  truth  of  the  statements  in  the 
application,  the  commissions  of  Massachusetts,  New  Hampshire 
and  New  York  have  power  to  specify  the  purposes  and  to  determine 
the  amount  of  securities  reasonably  necessary.  The  commissions  of 
Ohio  and  Wisconsin  have  the  additional  power  to  decide  the  char- 
acter of  the  securities  and  to  define  the  terms  of  issue. 

Four  commissions  have  complete  and  unrestricted  power  over 
security  issues,  that  of  Vermont  deriving  its  authority  from  a  general 
provision  to  prevent  overcapitalization,  and  those  of  Arizona, 
California  and  Illinois  from  detailed  provisions  in  special  public 
service  commission  acts. 

Less  than  20  per  cent  of  the  public  service  commissions  have 
any  discretionary  powers  on  questions  of  capitalization.  So  in- 
complete are  most  of  the  laws  that  many  commissions,  though  not 
permitted  by  law,  have  imposed  conditions  in  order  to  make  their 
control  effective  in  any  degree.  Commission  control  over  the  capi- 
talization of  public  service  corporations,  and  particularly  of  rail- 
roads, is  neither  universal  nor  uniform. 

The  public  commission  acts  provide  for  the  enforcement  of 
commission  control  over  the  security  issues  of  public  service  corpora- 
tions and  of  railroads  by  prescribing  the  proceedings  necessary  to 
validate  an  issue. 

Previous  permission  of  the  commission,  evidenced  by  a  certifi- 
cate of  authority,  must  be  had  in  eighteen  states  for  all  securities 

8  District  of  Columbia,  Georgia,  Indiana,  Kansas,  Maine,  Maryland,  Michigan, 
Missouri,  Nebraska,  New  Jersey. 


STATE  REGULATION  OF  SECURITIES 


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8  POWERS  AND  PROCEDURE 

issued  by  a  railroad  company.4  The  public  utility  corporations  of 
the  same  states,  with  the  exception  of  Texas,  are  subject  to  the  same 
provision,  and  also  those  of  the  District  of  Columbia  and  Indiana. 
Rhode  Island  requires  such  authority  for  the  stock  issues  of  street 
railways.  The  Pennsylvania  commission  has  no  power  on  its  own 
initiative  to  certify  to  an  issue,  but  must  do  so  if  the  corporation 
applies  for  a  certificate  of  valuation.  In  Texas,  the  certificate  is  in 
the  form  of  a  notice  to  the  Secretary  of  State  that  the  law  has  been 
complied  with,  especially  that  the  particular  issue  does  not  exceed 
the  value  of  the  property  covered  by  it.  The  certificate  of  the  other 
commissions  states  the  amount,  purposes  and  character  of  the  issue; 
that  the  amount  is  not  in  excess  of  the  amount  required  for  the 
specified  purposes;  and  that  no  part  of  the  amount,  except  when 
permitted  in  reference  to  bonds,  is  chargeable  to  operating  expense 
or  income.  When  the  commission  has  power  to  impose  conditions, 
these  are  also  set  forth  in  the  certificate. 

A  necessary  prerequisite  to  the  issue  of  a  certificate  is  an  applica- 
tion by  the  corporation  for  approval.  The  Texas  law  does  not 
require  a  previous  application,  but  the  rules  of  the  commission  call 
for  it  in  all  cases.  The  laws  of  several  states  contain  only  a  very 
general  clause,  demanding  a  written  application  to  be  made,5 
while  others  prescribe  the  contents  of  the  application.6  The  ap- 
plication contains  information  on  the  same  subjects  to  which  the 
commissions  must  certify  in  their  certificate  of  authority,  namely,  the 
amount,  character  and  purposes  of  the  issue,  the  terms  of  the  issue, 
and  a  description  and  estimated  value  of  any  property  or  services 
that  are  made  a  basis  of  the  issues. 

In  two  states,  Pennsylvania  and  Virginia,  the  filing  of  a  similar 
statement,  called  a  Certificate  of  Notification  in  Pennsylvania,  meets 
all  the  requirements  of  the  law,  and  the  corporation  is  subject  to  no 
further  control  in  matters  of  capitalization.  The  duty  of  the  com- 
missions of  these  states  is  fulfilled  by  placing  this  statement  on 
public  file. 

Previous  investigation  of  the  statements  in  the  application  is 
definitely  provided  for  in  the  statutes  of  many  states,  and  in  the 

4  Arizona,  California,  Georgia,  Illinois,  Kansas,  Maine,  Maryland,  Massachu- 
setts, Michigan,  Missouri,  Nebraska,  New  Hampshire,  New  Jersey,  New  York, 
Ohio,  Texas,  Vermont,  Wisconsin. 

1  Georgia,  Maine,  Massachusetts,  Michigan,  New  Hampshire,  Vermont. 

•  Indiana,  Kansas,  Ohio,  Wisconsin. 


STATE  REGULATION  OF  SECURITIES  9 

case  of  almost  every  application  the  commission  conducts  an  in- 
vestigation.7 The  commission  must  hold  a  public  hearing,  and  is 
empowered  to  make  additional  inquiry,  to  make  a  valuation  of  the 
property  of  the  corporation,  and  to  examine  such  witnesses,  books, 
documents  and  contracts,  and  to  require  the  filing  of  such  data  as  it 
may  deem  of  assistance  in  reaching  a  determination. 

If  the  commission  decides  to  permit  an  issue  of  securities,  its 
certificate  must,  in  several  states8  be  recorded  on  the  books  of  the 
company  before  securities  may  be  issued.  In  other  states,  the 
certificate  must  be  filed  with  the  Secretary  of  State.9 

To  insure  the  proper  disposition  of  the  proceeds  of  authorized 
issues,  various  provisions  are  found  in  the  state  statutes.  Wisconsin 
may  require  the  utility  to  perform  any  act  necessary  to  carry  out  the 
provisions  of  the  law.  Some  states  permit  their  commissions  to 
establish  any  rules  or  regulations  in  their  judgment  reasonable  and 
necessary  to  prevent  the  disposition  of  the  proceeds  for  any  purposes 
except  those  designated  in  the  order.10  A  detailed  accounting  of  the 
proceeds  is  called  for  by  some  laws,11  and,  in  practice,  by  all  com- 
missions. 

Failure  to  observe  any  of  the  provisions  in  the  act  is  punishable 
by  penalties  that  operate  against  the  security  issued,  the  corporation, 
and  the  officers  and  employes.  The  laws  of  nine  states  declare  all 
securities  void,  which  do  not  conform  to  the  law.12  There  is  a 
conflict  of  opinion  as  to  the  power  of  the  commission  to  validate  such 
illegal  issues.  Texas,13  California14  and  New  Hampshire16  require 
new  applications,  but  Nebraska16  and  Indiana17  validate  the  issue. 

7  Arizona,  California,  Georgia,  Illinois,  Maine,  Maryland,  Michigan,  Mis- 
souri, Nebraska,  New  Hampshire,  New  York,  Ohio,  Vermont,  Wisconsin,  and 
Pennsylvania  in  case  of  a  Certificate  of  Valuation. 

8  District  of  Columbia,  Kansas,  Missouri,  Wisconsin. 
*  Texas,  New  Hampshire,  Massachusetts. 

10  Arizona,  California,  Illinois,  Missouri,  Wisconsin. 

11  Arizona,  California,  Illinois,  Missouri. 

12  Arizona,  California,  District  of  Columbia,  Illinois,  Kansas,  Maine,  Ohio, 
Texas  and  Wisconsin. 

13  Public  Utility  Reports  Annotated  (hereafter  referred  to  as  P.  U.  R.),  1915, 
E531. 

14  Id.  A643,  1071. 
» Id.  E931. 

"  Id.  C24. 
17  Id.  B55. 


10  POWERS  AND  PROCEDURE 

If  there  is  no  need  to  change  the  terms  of  the  issue,  a  validating  order 
would  seem  sufficient,  without  compelling  the  corporation  to  recall 
the  unauthorized  securities  and  issue  an  identical  new  series,  with 
only  the  authority  of  the  commission  added.  The  penalty  im- 
posed on  the  utility  is  usually  a  fine,  ranging  from  $500  to  $20,000. 
The  agent  may  be  fined  -$500  to  $10,000  or  imprisoned  on  a  mis- 
demeanor charge  in  some  states,  on  a  felony  charge  in  others,  for  a 
term  of  one  to  fifteen  years,  and,  in  Texas,  is  personally  responsible 
to  the  creditors  for  the  full  amount  of  any  damage  sustained. 

The  administrative  control  of  security  issues  is  provided  for  in 
state  statutes  by  requiring  previous  permission  of  a  public  service 
commission,  which  is  granted  upon  application  and  after  investiga- 
tion. This  permission  must  be  recorded  in  some  states  upon  the 
books  of  the  corporation  or  with  the  Secretary  of  State.  The  pro- 
ceeds from  authorized  issues  must  be  strictly  accounted  for.  For 
any  failure  to  obey  the  law  severe  penalties  are  imposed,  the  least 
of  which  is  sufficient  impetus  to  a  close  observance  of  the  provisions 
of  the  statutes. 

Compelled  in  twenty-three  states  to  submit  to  some  measure 
of  supervision  by  a  public  commission,  the  public  service  corpora- 
tions and  railroads  are  served  with  a  notice  in  almost  all  states  that 
bhe  approval  of  the  commission  carries  no  guarantee.18  The  orders 
of  the  commission  often  contain  the  further  condition  that  such 
authority  shall  not  be  binding  upon  the  commission  or  any  other 
tribunal  as  a  finding  of  the  value  of  the  applicant's  property19  in  any 
rate  or  other  proceeding.  These  emphatic  declarations  that  the 
commission's  approval  carries  no  guarantee  of  value  or  dividends 
would  seem  to  uphold  the  frequently  repeated  assertion  that  securi- 
ties have  no  relation  to  rates.  In  practice,  however,  the  same 
commissions  have  considered  the  return  on  investment  which  a 
particular  rate  will  yield  before  making  any  change.20  Inversely  the 
ability  of  a  company  to  meet  interest  charges  has  been  the  justifica- 
tion for  authority  to  issue  securities.21 

In  rate  valuation  proceedings,  the  security  issues  almost  in- 
variably have  weight,  even  in  states  where  there  is  no  power  granted 

18  Arizona,  California,  Illinois,  Indiana,  Missouri,  Pennsylvania,  Texas. 

19  P.  U.  R.  1915,  B1072,  A557,  F795;  id.  1916,  B583,  A514. 
80  P.  U.  R.  1916,  A227,  A594,  C281,  C1020,  D25 

a  Id.  1915,  A744,  749 


STATE  REGULATION  OF  SECURITIES  11 

to  a  commission  over  securities.22  The  general  assurances  that 
securities  will  be  considered  have  been  translated  into  positive  action 
by  many  commissions,  rates  being  maintained  or  even  raised  in  order 
to  give  a  favorable  return  on  the  securities.23  The  Massachusetts 
Public  Service  Commission  has  taken  the  most  definite  stand  in  this 
matter,  holding  that  capital  honestly  and  prudently  invested  must 
be  taken  as  a  controlling  factor  in  fixing  a  basis  for  fair  rates,24  and 
that  the  approval  of  the  commission  is  conclusive  evidence  that  the 
issue  represents  legitimate  investment.25 

The  consequence  of  a  change  of  rates  upon  the  market  value 
of  securities  should  be  carefully  considered  by  all  commissions.  If 
strict  observance  is  required  of  the  provisions  that  securities  are  to 
be  issued  only  in  amounts  necessary  for  proper  purposes,  and  that 
full  value  in  assets  is  turned  into  the  corporation,  the  commissions 
will  best  guard  the  public's  interests  by  being  generous  and  fair  in 
rate  questions.  The  ordinary  risks  of  business,  however,  should 
not  be  insured  against  because  of  commission  approval  of  securi- 
ties except  that  rates  should  always  be  sufficient  to  provide  for 
obsolescence  as  well  as  depreciation.  The  best  relationship  between 
the  corporation  and  the  public  is  maintained  when  a  fair  return  is 
permitted  upon  a  fair  investment,  without  removing  the  spur  of 
responsibility  for  conservative  management  from  the  officers  of  the 
corporation. 

II 
STATE   STATUTORY   LIMITATIONS   ON   THE   ISSUE   OF   SECURITIES 

The  security  issues  of  public  service  corporations  that  are  sub- 
ject to  control  are  defined  to  be  stocks,  stock  certificates,  bonds, 
notes,  trust  certificates,  or  other  evidences  of  indebtedness,  payable 
at  more  than  twelve  months  after  date.  No  one  of  the  public 
service  acts  enters  into  more  detail.  The  lack  of  exact  definition 
has  been  a  marked  deficiency  of  all  the  laws.  What  constitutes  an 
issuance  of  such  securities  was  also  left  for  the  commissions  to  de- 
termine. As  interpreted  in  the  various  states,  control  has  been 
extended  far  beyond  the  original  issue  to  bona  fide  purchasers,  or 

22  P.  U.  R.  1916,  D976,  1915,  A618. 

23  Id.  1916,  A349,  276,  506;  1917,  A255. 
*Id.  1915,  B362;  1917,  A331. 

»  Id.  1915,  E370,  F264. 


12 


STATUTORY  LIMITATIONS 


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STATE  REGULATION  OF  SECURITIES  13 

for  retention  in  the  treasury  to  pledged26  and  reissued27  securities 
and  to  issues  to  effect  a  reorganization28  or  consolidation.29 

All  securities  issued  for  periods  of  less  than  twelve  months  are 
exempt  from  regulation.  The  Pennsylvania  commission  may,  in  its 
discretion,  extend  to  such  securities  the  provisions  that  require  a 
certificate  of  notification  to  be  filed.  Wisconsin  limits  such  issues 
to  those  that  are  made  for  money,  requiring  the  consent  of  the 
commission  if  issued  for  property  or  services.  Michigan  permits  an 
original  issue  for  twenty-four  months  without  consent  of  the  com- 
mission. The  other  states  place  no  restraints  upon  the  issue  of  such 
securities.  In  some  states  the  refunding  of  such  securities,  if  in  the 
form  of  an  issue  running  for  more  than  twelve  months,  must  not  be 
carried  out  without  the  consent  of  the  commission.30  In  other  states, 
the  refunding  in  whole  or  in  part  by  any  issue  of  securities  of  what- 
ever term  or  character  requires  the  consent  of  the  commission.31 
Illinois  further  forbids  their  renewal  from  time  to  time,  without 
consent,  for  an  aggregate  period  of  longer  than  two  years.  All  other 
states  require  consent  for  any  refunding  issue  that  is  to  run  for 
longer  than  twelve  months. 

The  interstate  character  of  the  corporation  or  of  a  particular 
issue  may  also  have  the  effect  of  a  partial  exemption.  Some  state 
laws  confine  supervision  to  domestic  corporations,32  in  which  case 
no  part  of  the  securities  of  a  foreign  corporation  need  to  be  approved. 
Other  states  apply  the  law  to  all  corporations  transacting  business 
within  the  state.33  The  Georgia  act  could  receive  the  last  interpre- 
tation, but  the  commission  has  refused  to  take  jurisdiction  over  the 
stock  issues  of  foreign  corporations,  or  over  the  bond  issues  of  a 
corporation  engaged  in  interstate  commerce.34 

The  location  of  the  property  that  is  the  basis  for  the  issue  is 

26  P.  U.  R.  1916,  A42. 

27  Id.  1916,  C1178. 

28  District  of  Columbia,  New  York,  Ohio,  Wisconsin,  Illinois,  Texas. 

29  All  Public  Service-  Acts,  except  those  of  Georgia,  Michigan,  Texas  and 
Vermont,  specifically  provide  for  control  over  consolidations  of  railroads  or  utilities 

30  Georgia,  Indiana,  Maryland,  Michigan,  Missouri,  Nebraska,  New  York, 
Ohio. 

81  Arizona,  California,  Illinois. 

M  Maine,  Maryland,  Nebraska,  New  York,  Vermont. 

w  District  of  Columbia,  Kansas,  Michigan,  New  Hampshire,  Ohio,  Wisconsin. 

14  National  Association  of  Railroad  Commissioners,  Proceedings,  v.  25,  p.  172 . 


14  STATUTORY  LIMITATIONS 

more  commonly  made  the  measure  for  jurisdiction.  The  acts  of 
Arizona,  California  and  Missouri  and  the  commission  ruling  of 
Illinois  apply  the  act  to  all  issues  that  are  based  upon  property 
within  the  state.  The  Arizona  commission  interpreted  this  provi- 
sion so  broadly  that  it  claimed  jurisdiction  over  the  bond  issue  of  a 
foreign  corporation,  although  there  was  no  lien  on  any  property 
within  the  state  and  none  of  the  proceeds  were  to  be  spent  within  the 
state,  because  it  was  not  clear  that  in  the  event  of  a  foreclosure  a 
deficiency  judgment  might  not  be  taken  against  Arizona  property.35 

If  the  proceeds  are  to  be  spent  without  the  state,  many  com- 
missions lose  control.  The  acts  of  Massachusetts  and  of  New 
Hampshire  exempt  such  part  of  an  issue  as  represents  expenditures 
outside  the  state.  The  Massachusetts  commission,  however,  does 
pass  upon  all  issues  by  domestic  corporations  and  must  be  notified 
of  the  details  of  the  entire  issue  by  a  foreign  corporation,  if  any  part 
of  the  proceeds  are  to  be  spent  in  Massachusetts.  The  Ohio  com- 
mission grants,  but  does  not  require,  its  approval  if  expenditures  are 
to  be  made  without  the  state.  The  Maryland  commission  claimed 
full  jurisdiction  over  all  issues  of  securities  by  domestic  corporations, 
but  the  courts  held  that  it  had  no  control  over  securities  the  proceeds 
of  which  were  to  be  spent  outside  the  state.36  With  these  excep- 
tions, the  laws  governing  the  issuance  of  securities  apply  to  every 
form  of  issue,  including  pledge,  whether  by  a  new,  existing,  reor- 
ganized, or  consolidated  company,  and  whether  for  property,  privi- 
leges, or  services. 

There  are  various  limitations  as  to  the  kind  of  security  that 
may  be  issued  under  certain  circumstances.  Those  states  which 
permit  the  issue  of  securities  for  operating  expenses  and  replacement 
require  them  to  be  in  the  form  of  bonds  or  notes.  Refunding  issues 
must  be  in  the  same  form  as  the  securities  they  are  retiring,  unless  a 
special  order  is  obtained  permitting  a  change. 

The  most  widespread  limitation  on  the  class  of  security  to  be 
issued  is  that  which  defines  the  proper  proportion  to  be  maintained 
between  bonds  and  stocks.  There  is  no  limit  to  bond  issues  in  Missis- 
sippi, and  several  other  states  give  the  directors  full  power  to  de- 
termine the  amount.  Arizona,  California  and  Illinois  permit  their 
commissions  to  authorize  issues  of  bonds  in  an  amount  equal  to, 

»  P.  U.  R.  1916,  B8. 
"88  Atl.  348. 


STATE  REGULATION  OF  SECURITIES  15 

less  than,  or  greater  than  the  capital  stock.  The  Arizona  commis- 
sion has  favored  the  restriction  of  bonds  to  the  amount  of  stock, 
while  that  of  California  has  declared  that  70  per  cent  of  the  capital 
in  the  form  of  bonds  is  the  maximum  to  be  authorized.37  Bonds  were 
limited  to  50  per  cent  of  the  capital  in  the  case  of  a  California  water 
company  owning  wells  that  might  not  be  permanent.38  A  Con- 
necticut law  prevents  the  issue  of  bonds  in  excess  of  one-half  the 
amount  actually  expended  on  the  railroad.39  The  Texas  law  makes 
the  value  of  the  property  the  limit  for  bonds.  The  laws  of  Indiana 
and  Wisconsin  declare  in  general  terms  that  the  indebtedness  of  the 
corporation  shall  bear  a  reasonable  proportion  to  the  stocks  issued 
by  the  corporation.40 

The  definite  proportion  that  must  be  maintained  between  stocks 
and  bonds  is  prescribed  in  many  states.40  The  most  common  re- 
quirement is  that  the  bonds41  or  total  indebtedness42  shall  not  ex- 
ceed the  capital  stock,  modified  in  Montana  and  New  Mexico  by  the 
amount  subscribed.  Connecticut43  and  New  Jersey  limit  the  total 
indebtedness  to  the  stock  paid  in,  but  bonds  to  twice  this  amount 
may  be  issued  in  other  states.44  The  maximum  amount  of  bonds  is 
limited  to  two-thirds  of  the  capital  stock  in  Iowa,  Nebraska  and 
Utah.  In  Minnesota,  the  indebtedness  exclusive  of  mortgage  bonds 
must  not  exceed  two-thirds  of  the  capital  stock,  but  the  total  in- 
debtedness may  be  three  times  the  capital  stock.  An  interstate 
corporation  may  find  itself  conforming  to  the  Jaws  of  one  state  only 
to  defy  those  of  another.  An  established  proportion  between  stocks 
and  bonds  is  necessary  to  compel  the  owners  to  put  into  the  business 
enough  to  make  it  to  their  interest  to  maintain  the  property  in  an 
efficient  condition,  rather  than  to  exploit  it  to  secure  dividends. 
Merely  to  condition  the  amount  of  bonds  on  the  total  securities 
does  not  meet  the  situation,  especially  if  the  stock  is  not  fully  paid. 
The  bonds  should  be  in  proportion  to  the  total  value  of  the  assets 
and  not  to  any  quality  of  the  capital  stock.  In  quantity,  there  is 

37  P.  U.  R.  1915,  A787,  D347. 

38  Id.  1915,  B38. 

39  Code  1902,  sec.  3804. 

40  For  exact  reference  see  Table  II. 

41  Arkansas,  Idaho,  Maryland,  Missouri,  Nevada,  Ohio. 

42  Idaho,  North  Dakota,  Oklahoma,  South  Dakota,  Washington,  Wyoming. 

43  Code  1902,  sec.  3804. 

44  Delaware,  Massachusetts,  Pennsylvania,  Washington. 


16  STATUTORY  LIMITATIONS 

already  an  overabundance  of  legislation,  but  there  is  need  of  the 
adoption  of  a  basis  that  will  give  greater  definiteness. 

Securities  of  whatever  character  must  be  issued  only  for 
legitimate  purposes.  The  chief  duty  of  the  commissions  is  to  see  to 
this  requirement.  To  leave  no  doubt  that  the  commission's  deci- 
sion is  final,  many  states  forbid  the  utility  or  railroad  to  apply  the 
proceeds  of  securities  to  any  purposes  not  specified  in  the  commis- 
sion's certificate,45  nor  in  excess  of  the  amount  authorized.46  The 
majority  of  commissions  are  limited  at  the  outset  to  inquiring 
whether  the  issue  under  consideration  is  for  purposes  in  accord  with 
the  nature  of  the  business  carried  on  by  the  particular  corporation. 
The  unnecessary  duplication  of  facilities  by  competing  companies 
may  continue  unchecked.47  The  commissions  of  Ohio  and  Vermont 
have  been  given  the  right  to  reject  the  applications  if  not  convinced 
that  the  proceeds  will  be  spent  for  the  general  good  of  the  public, 
and  the  acts  of  California,  Arizona  and  Illinois  permit  of  the  same 
broad  interpretation.  A  few  other  commissions,  as  Maine,48  by  a 
liberal  interpretation  of  their  power  in  regard  to  certificates  of  con- 
venience and  necessity,  may  prevent  duplication  of  plants  in  the 
interest  of  the  public.  Every  unnecessary  duplication  of  any  part 
of  a  public  service  corporation's  plant,  used  solely  for  competitive 
purposes,  results  in  reducing  to  scrap  value  that  much  of  the  prop- 
erty of  one  or  both  companies.  Where  the  evils  of  competition  and 
its  wasteful  extravagances  are  not  prevented  by  public  control,  the 
burdens  of  the  utility  are  unjustly  increased  and  the  public  in  no 
manner  benefited.  Every  commission  should  have  the  power,  and 
it  should  be  its  duty,  to  coordinate  the  corporate  with  the  public 
needs,  by  preventing  the  issue  of  securities  for  unnecessary  construc- 
tion. 

The  purpose  for  which  securities  may  be  authorized,  as  set 
forth  in  the  laws,  fall  into  five  general  classes : 

1.  The  acquisition  of  property. 

2.  The  construction,  completion,  extension,  or  improvement  of  its  facilities  or 
properties. 

46  Arizona,  California,  Illinois,  Kansas,  Massachusetts,  Missouri,  New  Hamp- 
shire, New  York,  Ohio,  Wisconsin. 

46  Arizona,  California,  Illinois.    See  Table  II. 

47  P.  U.  R.  1915,  B55,  D160;  1916,  C42. 
41  Id.  1916,  A418. 


STATE  REGULATION  OF  SECURITIES  17 

3.  The  improvement  of  maintenance  of  its  service. 

4.  The  discharge  or  lawful  refunding  of  its  obligations. 

5.  The  reimbursement  of  the  treasury49  for  moneys  actually  expended  from 
income,  or  from  any  other  moneys  in  the  treasury  not  secured  by  the  issue  of 
stocks  or  bonds. 

The  first  group,  the  acquisition  of  property,  includes  the 
purchase  of  rights  of  way  and  of  other  necessary  real  estate,  and  the 
acquisition  of  the  property  or  securities  of  related  systems.  The 
securities  must  represent  a  permanent  addition  to  the  facilities  of  the 
railroad  or  utility.  The  public  service  acts  of  ten  states  forbid  the 
capitalization  of  the  right  to  be  a  corporation,  or  the  capitalization 
of  any  contract  for  consolidation  or  lease.50  If  issues  were  allowed 
for  such  purposes,  they  would  rest  upon  anticipated  earnings  and 
not  on  present  assets,  always  a  doubtful  proceeding,  particularly 
unjustifiable  in  the  case  of  railroads  and  public  utilities. 

The  second  group  covers  all  the  basic  equipment  that  directly 
furthers  the  company's  business,  including  the  cost  of  welfare  build- 
ings, when  not  directed  beyond  suitable  provision  for  the  health  and 
safety  of  .employes.51  What  proportion,  if  any,  of  the  securities 
authorized  for  construction  costs  should  be  credited  to  promotion 
fees  has  not  been  decided  uniformly  by  the  state  commissions. 
In  recognition  of  the  value  of  the  services  of  the  promoter,  Iowa 
passed  a  law  in  1911  requiring  the  labor  performed  in  effecting  the 
promotion  of  steam  and  electric  railways  to  be  taken  into  account  in 
fixing  the  amount  of  capital  stock.  The  Maine  commission  author- 
ized the  issue  of  stock  to  the  promoter  of  a  railroad,  although  only 
preliminary  organization  work  had  been  done.52  The  California 
commission  authorized  stock  to  the  par  of  $75,000  for  promoter's 
services  in  projecting  a  railroad  that  could  be  financed  at  a  sum  not 
to  exceed  $750,000.53  These  rulings  partake  of  extremes  in  expres- 
sing appreciation  of  the  work  of  the  promoter,  but  are  based  on  a 
correct  principle,  for  the  work  of  the  promoter  in  the  field  of  modern 

49  Arizona,  California,  Illinois,  Indiana,  Missouri,  New  York,'  Ohio,  Wisconsin. 
The  other  four  groups  are  mentioned  in  the  laws  of  these  states  and  of  Georgia, 
Kansas,  Maine,  Maryland,  Massachusetts,  Michigan,  Nebraska,  New  Hampshire. 

60  Arizona,  California,  Illinois,  Indiana,  Maryland,  Missouri,  Nebraska,  New 
York,  Ohio,  Wisconsin. 

61  P.  U.  R.  1915,  B582. 

62  P.  U.  R.  1916,  D260. 

63  Id.  1915,  F311. 


18  STATUTORY  LIMITATIONS 

industry  is  co-important  with  the  work  of  the  engineer,  and  a  condi- 
tion precedent  to  the  latter's  employment.  Less  favorable  consider- 
ation has  been  accorded  the  promoter  in  Arizona,54  Massachusetts,65 
New  Jersey56  and  Ohio.  The  Maryland  commission  has  declared 
that  the  cost  of  financing  through  promotion  agents  is  a  proper 
operating  expense.57  There  are  few  commissions  that  do  not  take 
this  factor  into  account,  although  they  may  refuse  an  award  under 
that  name.  All  states  permit  of  the  issue  of  securities  to  meet 
engineering  costs.  The  large  engineering  firms  are  taking  a  lead  in 
the  promotion  field.  Their  work  of  organizing  and  financing  the 
project  is  distinct  from  the  work  of  actual  construction,  but  a  single 
fee  may  be  received  for  the  completed  project,  the  promotion  costs 
being  absorbed  in  the  engineering  costs. 

The  third  group,  improvement  or  maintenance  of  service,  places 
a  heavy  burden  of  interpretation  upon  the  commissions,  in  determin- 
ing what  may  properly  be  included  under  this  classification.  Working 
capital  falls  under  this  division.  The  Massachusetts  Railroad  Com- 
mission refused  to  authorize  securities  for  this  purpose.  To  meet 
the  special  need  of  street  railways,  a  law  was  passed  permitting  the 
issue  of  stock  to  provide  working  capital,  not  to  exceed  5  per  cent  of 
outstanding  stock,  or  an  issue  of  bonds  to  an  amount  determined  by 
the  commission.58  In  general,  the  commissions  authorize  securities 
to  provide  working  capital,  in  an  amount  varying  with  the  nature 
and  extent  of  the  business.69  Operating  expenses  and  replacements 
also  belong  in  the  third  group.  They  may  not  be  capitalized  in  the 
form  of  stocks  in  any  part  of  the  Union  It  lies,  however,  within 
the  discretion  of  several  commissions  to  concur  in  the  issue  of  bonds 
or  notes  for  these  purposes.60  In  every  state,  permission  is  with- 
held unless  the  corporation  proves  its  ability  and  willingness  to  make 

M  P.  U.  R.  1915,  B1043. 

65  Id.  1915,  A15. 

w  Id.  1916,  D77. 

67  Id.  1916,  B925. 

M  Acts  of  1909,  C.  485. 

69  California,  P.  U.  R.  1915,  E834;  Illinois,  id.  1915,  F235,  1916,  C281,  704; 
Indiana,  1915,  C561;  Missouri,  id.  1916,  F49;  Nebraska,  id.  1915,  B416,  D160, 
1917,  A907;  New  Jersey,  id.  1915,  B601;  New  York,  Public  Service  Commission 
Reports,  Hearings  and  Decisions,  I,  166. 

60  Arizona,  California,  Illinois,  Missouri,  New  York,  Ohio,  Wisconsin;  see 
Table  II  under  "Purposes"  for  references.  Massachusetts,  Acts  1914,  ch.  671 
(street  railways). 


STATE  REGULATION  OF  SECURITIES  19 

good  out  of  earnings  the  amount,  either  by  direct  payments  to  a 
sinking  fund,  or  by  investments  in  capital  assets.61  The  New  York 
Second  District  Commission  has  well  summarized  the  advantages 
accruing  from  permitting  issues  for  operating  expenses,  declaring 
that: 

this  policy  enables  the  companies  to  absorb  early  losses  ....  to  continue 
to  serve  the  public  without  interruptions  uniformly  attendant  upon  receiverships 
.  .  .  .  and  makes  them  comparable  to  industrials  and  other  unregulated  fields 
for  investment,  so  far  as  the  possibilities  attendant  upon  external  development  are 
concerned.62 

Where  the  power  to  authorize  issues  for  replacements  and  operat- 
ing expenses  is  conservatively  exercised,  it  may  prove  of  public 
benefit  in  those  cases  where  an  insufficient  depreciation  fund  has 
been  carried,  and  an  inefficient  service  will  result  from  a  continued 
use  of  obsolete  or  worn  out  equipment.  The  requirement  of  a 
restoration  to  the  capital  account  of  an  equal  amount  reduces  the 
measure  to  a  purely  temporary  expedient.  The  railroads,  as  a  whole, 
have  no  need  of  availing  themselves  of  this  privilege.  The  en- 
forcement of  present  day  stringent  accountancy  rules  will  soon 
obviate  the  need  of  any  utility  resorting  to  this  method,  by  compel- 
ling the  maintenance  of  adequate  depreciation  funds. 

The  fourth  group,  the  discharge  or  lawful  refunding  of  the 
company's  obligations,  presents  no  particular  problem  of  interpreta- 
tion. 

The  fifth  group,  reimbursement  of  the  treasury  for  funds  em- 
ployed in  the  extension,  improvement  and  betterment  of  the  proper- 
ties of  the  utility  corporation  or  railroad  receives  unanimous  ap- 
proval by  all  commissions,  when  the  securities  are^to  be  sold  and  the 
funds  turned  into  the  treasury.63 

When  such  securities  are  in  the  form  of  stocks  to  be  distributed 
in  lieu  of  a  cash  dividend,  there  is  a  decided  divergence  of  opinion  as 
to  the  propriety  of  consenting  to  their  issuance.  The  act  creating  a 
commission  for  the  District  of  Columbia,  and  the  laws  of  Massachu- 
setts, New  Hampshire  and  South  Carolina  forbid  scrip  dividends. 
The  courts  of  South  Carolina,  however,  have  held  that  the  capitaliza- 
tion of  a  new  company  formed  to  purchase  the  property  of  two  exist- 

61  P.  U.  R.  1916,  C769,  D551;  id.  1917,  A889. 

62  New  York,  Public  Service  Commission,  Second  District  Ninth  Annual 
Report,  v.  I,  p.  7. 

"  94  Atl.  193. 


20  STATUTORY  LIMITATIONS 

ing  companies  at  full  value,  though  in  excess  of  the  capitalization  of 
the  existing  companies  is  not  in  violation  of  this  statute,  even  if  the 
securities  are  to  be  taken  by  the  stockholders  of  the  old  corpora- 
tions.63 According  to  this  decision,  the  law  may  be  circumvented 
without  very  great  inconvenience  and  is  practically  nullified.  Some 
commissions,  as  Ohio,  favor  the  sale  of  such  securities,  in  place  of  a 
direct  issue  to  the  stockholders,  and  the  distribution  of  the  funds  as 
a  cash  dividend.64 

Many  state  laws  permit  stock  dividends  in  an  amount  rep- 
resented by  actual  investment  in  the  corporation  of  net  ^earnings.65 
The  commissions  of  California,66  Illinois,67  Indiana68  and  New  Jer- 
sey69 have  rendered  decisions  to  the  same  effect.  The  advantages  of 
permitting  stock  dividends  are  several.  Some  surplus  is  essential  to 
every  corporation  to  provide  for  emergencies  and  to  stabilize  divi- 
dends. To  keep  this  in  the  form  of  idle  cash  is  an  economic  waste. 
To  put  it  entirely  into  outside  investments,  which  the  management 
cannot  control,  is  a  risk,  to  lessen  which  unusually  small  returns  must 
be  accepted  by  investing  in  preferred  securities.  By  the  employ- 
ment of  the  surplus  in  its  own  business,  a  corporation  is  enabled  to 
make -improvements  when  needed  acting  independent  of  conditions 
in  the  money  market,  and  to  do  so  without  the  payment  of  interest. 
The  public  is  saved  this  interest  charge,  since  the  corporation  may 
not  exact  interest  on  its  own  funds,  but  may  only  issue  securities  to 
the  amount  of  the  net  property  addition.  With  the  present  powers 
of  investigation  possessed  by  commissions,  there  is  no  danger  in 
permitting  the  investment  of  a  corporation's  surplus  in  its  own  prop- 
erty, and  the  distribution  of  a  stock  dividend  when  the  improve- 
ments are  completed.  This  is  particularly  just  when  the  owners 
have  refrained  from  all  dividends  in  order  to  build  up  the  credit  of 
the  corporation. 

The  legitimate  purposes  as  defined  in  the  laws  are  sufficiently 
broad  not  to  check  the  healthy  expansion  of  public  service  corpora- 
tions entirely  intrastate,  but  the  conflicting  interpretations  by  the 

"  P.  U.  R.  1915,  A483. 

"  Kansas,  Maine,  Missouri,  Ohio,  Wisconsin,  West  Virginia  (see  Table  II). 

M  P.  U.  R.  1915,  C324. 

•7  Id.  1915,  A205. 

68  Id.  1915,  A540. 

"  Id.  1915,  E72. 


STATE  REGULATION  OF  SECURITIES  21 

different  state  commissions  retard  the  fullest  development  of  inter- 
state corporations. 

Railroads  and  public  utilities  are  limited  not  only  as  to  the 
character  of  the  securities  and  the  purposes  for  which  they  may  be 
issued,  but  also  as  to  what  may  be  received  in  payment  for  securities. 
Many  states  have  constitutional  provisions  to  the  effect  that  stocks 
or  bonds  may  not  be  issued  except  for  an  equivalent  in  money  paid, 
labor  done  or  property  actually  received  and  applied  to  the  purposes 
for  which  the  corporation  was  created ;  that  all  fictitious  increase  of 
stock  or  indebtedness  is  void;  and  that  neither  labor  nor  property 
may  be  received  in  payment  at  a  greater  value  than  the  market 
price  at  the  time  such  labor  was  done  or  property  received.70  The 
same  provision  is  incorporated  in  the  statutes  of  many  states.71 
The  purpose  of  such  statutes  is  to  restrict  issues  to  actual  invest- 
ment, and  they  are  therefore  constitutional.72 

The  enforcement  of  these  provisions  is  left  entirely  to  the 
directors  in  several  states,  and  their  judgment  may  be  reversed  only 
in  fraud  proceedings.73  If  the  issue  is  for  other  than  money,  Iowa 
requires  the  consent  of  the  Executive  Council  of  State,  which,  if 
necessary,  may  make  an  investigation  and  ascertain  the  real  value 
of  the  property  to  be  transferred.74  In  Vermont  the  issue  of  shares 
of  stock  for  property  is  subject  to  special  approval  by  the  share- 
holders, to  whom  all  particulars  must  be  submitted.75  Other  states 
have  made  it  the  duty  of  their  commissions  to  enforce  the  provisions 
as  to  the  form  of  payment.  In  Virginia,  if  the  securities  are  issued 
for  property  or  services  already  received,  the  commission  may  in- 
vestigate the  value  of  the  property.  Texas  requires  special  approval 
of  the  commission  if  bonds  are  to  be  issued  in  advance  of  the  com- 
pletion of  a  railroad.  In  Wisconsin,  a  railroad  or  utility  is  restricted 
in  the  issue  of  securities  for  services  or  property  to  the  true  money 
value,  as  determined  by  the  commission,  in  an  amount  equal  to  the 

70  Alabama,  sec.  234;  Arizona  XV,  4;  Arkansas  XII,  4;  California  XII,  11; 
Delaware  IX,  3;  Idaho  XI,  9;  Illinois  XI,  13;  Kentucky,  sec.  193;  Louisiana,  sec. 
266;  Mississippi,  sec.  196;  Missouri  XII,  8;  Nebraska  XI,  5;  South  Carolina  IX, 
10;  South  Dakota  XVII,  8;  Utah  XII,  5;  Virginia,  sec.  167. 

71  See  Table  II  under  payment. 

72  P.  U.  R.  1915,  A618  (Massachusetts). 

73  Delaware,  Pennsylvania,  South  Dakota,  West  Virginia. 

74  Code  1913,  sec.  1641b. 

71  Laws  of  1910,  143,  sec.  6. 


22  STATUTORY  LIMITATIONS 

face  value  of  the  stocks  and  not  less  than  75  per  cent  of  the  face 
value  of  the  bonds. 

The  decisions,  of  the  commissions  conflict  as  to  the  proper 
measure  of  the  value  of  the  property,  whether  actual  cost,  reproduc- 
tion new,  or  present  value.  The  Maryland  commission  refused  to 
authorize  the  issuance  of  securities  beyond  the  value  of  a  public 
service  company's  property,  although  the  company  had  actually 
expended  in  the  plant  a  larger  sum  than  it  sought  to  capitalize.76 
In  contrast,  New  Hampshire  granted  authority  to  issue  securities  to 
cover  the  actual  cost  of  construction,  although  a  valuation  showed 
a  present  cost  of  reproduction  new  somewhat  less  than  the  actual 
cost.77  The  Texas  law  permits  the  purchasers  of  a  railroad  to  issue 
securities  to  the  full  value  of  the  property,  irrespective  of  the  pur- 
chase price.  The  California  commission  gave  consent  to  a  reorgani- 
zation plan  that  involved  the  issue  of  securities  beyond  the  value  set 
by  the  company.78  In  Maine,  a  company  was  denied  the  right  to 
capitalize  more  than  the  purchase  price.79  Extreme  liberality  was 
displayed  by  the  Maine  commission  in  another  case,  when  it  author- 
ized the  issue  of  bonds,  although  the  company  had  no  physical 
property.80  Such  inharmonious  decisions  introduce  a  measure  of 
uncertainty  that  is  particularly  disturbing  in  the  case  of  railroads 
that  are  national  in  scope,  whatever  the  length  of  line  in  any  one 
state. 

These  same  principles  apply  to  reorganizations  and  consolida- 
tions. Georgia  and  Wisconsin  limit  issues  of  securities  in  such 
cases  to  the  fair  value  of  the  property.  The  California  commission 
has  not  been  strict  in  valuations  for  this  purpose,  in  one  case  making 
j  no  effort  to  eliminate  undue  expense  in  connection  with  the  property.81 
-Several  states  provide  that  the  stock  of  consolidated  corporations 
must  not  exceed  the  aggregate  capital  stock  of  the  corporations 
consolidated  at  the  par  value  and  any  additional  sum  paid  in  cash.82 
The  total  amount  of  securities  that  may  be  issued  upon  the  re- 

76  P.  U.  R.  1915,  A812. 
"P.  U.K.  1915,  E931. 

78  Id.  C807. 

79  Id.  E109. 
M/d.  1916,  D260. 

81  Id.  1915,  F569. 

82  District  of  Columbia,  Illinois,  Maryland,  Missouri,  Nebraska,  New  York, 
Ohio. 


\ 
STATE  REGULATION  OF  SECURITIES  23 

organization  of  a  corporation  is  limited  to  the  fair  value  of  the  prop- 
erty in  Pennsylvania,  as  determined  by  the  commission  in  Illinois, 
New  York  and  Texas.  Ohio  permits  an  issue  to  the  full  value  of  the 
old  securities.  When  the  amount  of  securities  is  conditioned 
on  the  sum  of  the  securities  of  the  separate  companies  the  new 
issues  partake  of  all  the  evils  of  the  old.  If  the  par  of  such  securi- 
ties is  more  than  the  real  value  of  the  properties,  the  "  water " 
is  not  eliminated.  If  the  par  represents  less  than  the  real  value,  the 
owners  are  penalized  to  the  extent  of  the  difference,  when  they  should 
be  rewarded  for  their  thrift  in  increasing  the  assets  of  the  corporation 
out  of  savings.  The  issue  of  securities  to  the  fair  value  of  the  prop- 
erty, as  determined  by  the  commission,  whether  greater  or  less  than 
the  par  of  the  old  securities,  is  the  most  just  method,  and  the  only 
one  really  ensuring  value  received. 

PAR  VALUE  AND  SELLING  PRICE 

If  the  many  state  laws  which  limit  securities  to  a  reasonable 
amount  for  lawful  purposes  and  require  the  corporation  to  receive 
value  in  full,  were  universally  executed,  no  stock  would  sell  for  less 
than  par  and  bonds  would  sell  for  their  exact  value,  a  condition  only 
approximated  in  a  few  states. 

The  par  itself,  as  prescribed  in  the  statutes,  is  far  from  uniform. 
Some  states  leave  the  decision  to  the  board  of  directors.  In  Ten- 
nessee, railroad  stocks  may  be  issued  with  a  par  of  $100  or  less.  In 
Colorado,  the  par  may  vary  from  $1  to  $100,  in  Maryland  and 
Pennsylvania  it  must  be  $50,  in  the  majority  of  states  it  is  placed 
at  $100.83  Railroad  bonds  may  have  a  par  of  $50  in  Iowa,  $100  in 
Massachusetts  and  Vermont,  $500  in  Nebraska,  and  $1,000  in 
Wyoming.  The  maximum  interest  on  bonds,  which  partly  deter- 
mines market  price,  is  fixed  at  6  per  cent  in  Texas,  7  per  cent  in 
Arkansas,  Massachusetts  and  Ohio,  at  8  per  cent  in  Iowa,  and  at  10 
per  cent  in  Michigan,  Nebraska  and  Wyoming. 

The  par  of  the  securities  of  many  corporations  has  no  relation 
to  the  value  of  the  property,  and  consequently  the  selling  price  and 
the  par  value  are  rarely  equivalent  terms.  The  states  which  have 
not  conferred  on  their  commissions  power  to  regulate  securities  give 

83  Arizona,  Connecticut,  Florida,  Georgia,  Massachusetts,  Michigan,  Missis- 
sippi, Montana,  Nebraska,  New  Hampshire,  Vermont,  Virginia  (See  Table  I, 
"Par"). 


24  STATUTORY  LIMITATIONS 

the  directors  full  power  to  set  the  price.  Virginia  also  leaves  the 
price  to  be  determined  by  the  directors.  Some  commissions  have 
unlimited  power  to  fix  prices.84  Ohio  has  agreed  to  a  price  as  low 
as  80  for  stocks,  the  policy  of  the  California  commission  is  not  to 
allow  a  price  less  than  80-85  as  a  minimum,85  and  Illinois  requires 
par  to  be  received.  The  sale  of  stock  at  less  than  par  is  permitted 
in  Indiana  and  Georgia  if  agreed  to  by  the  commission,  which, 
except  in  such  a  case,  does  not  have  power  to  fix  the  price.  Railroad 
stocks  may  not  be  sold  for  less  than  par  in  Maine.  In  the  case  of 
other  utilities,  the  commission  will  not  authorize  the  sale  of  a  stock 
at  less  than  par  by  a  new  corporation,  but  holds  itself  free  to  do  so 
in  the  case  of  an  existing  corporation.86  Other  commissions  require 
all  stock  to  be  paid  in  full.87 

An  exception  to  the  requirement  of  all  sales  at  par  is  made  in 
New  York  in  the  case  of  convertible  railroad  bonds.  The  New  York 
law  authorizes  the  conversion  of  railroad  bonds  into  stock  at  less  than 
its  par  value,  but  not  less  than  the  market  price  at  the  time  of  the 
stockholders'  consent  to  the  bond  issue.88  In  Maine,  Massachusetts 
and  New  Hampshire  railroad  stocks  must  be  sold  neither  for  less  than 
par  nor  less  than  the  market  price.89  The  same  law  holds  for  public 
utilities,  except  in  Maine  where  the  commission  may  permit  the  sale 
of  such  stock  for  less  than  par,  but  has  refused  to  do  so  in  the  case  of 
any  new  company.90  In  these  states  the  stock  must  first  be  offered 
to  the  stockholders,  and  all  shares  not  so  disposed  of  must  be  offered 
at  public  auction  under  the  same  restrictions  as  to  par  and  market 
price.  With  the  exception  of  the  New  England  states,  it  is  not 
customary  for  the  commission  to  set  the  price,  if  above  par,  but  the 
rule  is  that  the  sale  be  made  at  the  highest  price  obtainable,  not  less 
than  par. 

To  require  bonds  to  be  sold  at  par  is  the  exception.  The  Mas- 
sachusetts commission  discourages  the  sale  at  less  than  par.  The 
Maine  commission,  however,  holds  that  it  is  not  its  policy  to  refuse 

84  Arizona,  California,  Illinois,  Ohio. 

85  P.  U.  R.  1916,  C779. 
88  Id.  1915,  C361. 

87  Michigan,  Missouri,  New  Jersey,  New  York,  Texas,  Wisconsin. 

88  Railroad  Law,  sec.  8,  sub.  10. 

89  See  Table  II  under  Selling  Price. 

90  P.  U.  R.  1915,  C361;  also  Maine,  Public  Utility  Commission  Report,  v. 
II,  p.  298. 


STATE  REGULATION  OF  SECURITIES  25 

to  authorize  issues  of  bonds  for  less  than  par.89  The  minimum  price 
in  Indiana  and  Wisconsin  is  75  per  cent  of  par.90  Texas  requires  that 
full  value  be  received  for  bonds,  preventing  a  sale  for  less  than  par.89 
Some  states  permit  the  sale  of  bonds  at  the  price  determined  by  the 
board  of  directors.91  Missouri  has  allowed  bonds  to  be  sold  as  low 
as  70,  and  Illinois  for  73.  New  Jersey  and  Michigan  favor  a  mini- 
mum of  80.  The  price  of  bonds  is  determined  by  such  factors  as 
the  rate  of  interest,  the  life  of  the  bond,  the  degree  of  security, 
the  method  of  payment  and  any  privileges,  such  as  the  right  to 
convert  into  stock.  The  price  is  determined  by  the  current  rate  for 
money  for  similar  investments,  and  a  uniform  price  is  neither  possible 
nor  desirable. 

The  difference  between  the  face  value  of  the  bonds  and  the 
selling  price  measures  the  cost  to  the  corporation  of  obtaining  money 
at  a  given  rate  of  interest.  The  Iowa  law  is  based  on  a  false  founda- 
tion, which  authorizes  the  bond  discount  to  be  taken  into  account 
as  an  element  of  value  in  fixing  the  amount  of  capital  stock  that 
may  be  issued.92  Bond  discount  is  an  expense,  which  the  state 
commissions,  in  all  valuation  proceedings,  require  to  be  amortized 
out  of  income.93 

Ill 
SUMMARY  AND  CONCLUSION 

The  charges  of  incompleteness  or  inadequacy  or  both  may  be 
placed  against  many  of  the  laws  controlling  the  security  issues  of 
railroads.  Where  no  special  administrative  body  is  entrusted  with 
their  enforcement,  they  remain  inoperative,  unless  some  noteworthy 
misapplication  of  power  by  the  directors  arouses  public  opinion. 
The  pure  publicity  provisions  in  the  public  utility  acts  of  Pennsyl- 
vania and  Virginia  are  no  improvement  over  all  absence  of  com- 
mission control.  Filing  as  a  public  document  is  not  synonymous 
with  making  public.  More  complete  information  is  more  readily 
obtained  from  banker  or  stockbroker.  The  expenses  of  manage- 
ment of  railroads  and  public  service  corporations  are  increased  with- 
out any  benefit  to  the  public,  the  investor  or  the  corporation. 

91  Delaware,  Iowa,  Louisiana,  Nebraska,  Utah  and  Wyoming,  see  Table  II, 
final  column. 

92  Code  1913,  sec.  1641b. 

•»  California  P.  U.  R.  1915,  E197;  District  of  Columbia  id.  1915,  B546; 
Illinois  id.  1915,  A804;  Massachusetts  id.  E370,  Missouri  id.  1916,  E544;  Ohio  id. 
1916,  E670. 


26  SUMMARY  AND  CONCLUSION 

Slightly  more  justifiable  are  the  statutes  which  require  the 
commission  to  investigate  the  statements  made  in  the  application. 
The  mandate  resting  on  these  commissions,  however,  either  to 
accept  or  reject  the  application  in  the  form  submitted,  has  caused 
them  to  exercise  extra-legal  powers  by  imposing  conditions.  Such 
action  is  proof  of  the  inadequacy  of  the  law.  It  is  the  law  as  it 
stands,  and  not  as  enlarged  by  the  dangerous  practice  of  reading  into 
it  increased  powers,  that  is  to  be  criticised.  Judged  on  its  own 
merits  this  type  of  control  is  highly  deficienf ,  for  it  imposes  more 
burdens  than  pure  publicity,  while  the  gains  are  only  problematical, 
certainly  not  proportionately  greater. 

Some  power  should  be  granted  the  commission  to  modify  the 
application,  with  due  recognition  that  the  danger  from  extremes  is 
not  less  in  granting  too  much  than  in  granting  too  little  discretion. 
So  long  as  salaries  are  low,  qualifications  for  public  office  less,  and 
the  power  of  appointment  exercised  to  distribute  political  plums 
rather  than  to  reward  ability,  it  is  inviting  disaster  to  substitute  un- 
conditionally the  judgment  of  public  officials  for  that  of  persons  of 
long  special  training.  The  value  of  commission  control  rests  upon 
the  ability  of  the  commissioners  to  act  as  detached,  impartial  ob- 
servers, checking  but  not  replacing  the  decisions  of  corporate  offi- 
cials, whose  judgment  may  be  warped  by  too  narrow  attention  to  a 
single  interest. 

Present  legislation  is,  as  a  whole,  unsatisfactory,  protecting 
neither  the  public  nor  the  corporation  and  its  investors.  Despite 
its  imperfection,  this  legislation  has  been  in  response  to  a  rapidly 
growing  realization  that  the  physical  plant  of  a  railroad  or  public 
utility  is  not  a  gift  out  of  the  clouds;  that  regulation  of  rates  and 
services  is  only  partial  regulation,  necessitating  the  inclusion  of 
securities  to  round  out  the  circle. 

Control  of  securities  is  necessary  to  protect  the  corporation 
against  itself.  In  fact,  " Chapters  in  Erie,"  the  Chicago  and  Alton 
deal  and  similar  abuses  of  corporate  powers  gave  rise  to  the  agitation 
for  the  control  of  securities.  The  recent  financial  troubles  of  the 
Rock  Island,  the  Frisco  and  other  railroads  are  modern  evidences 
that  the  corporation  might  profit  from  a  review  of  the  directors' 
decisions  by  an  impartial  tribunal. 

Protection  of  the  investor  is  also  of  vital  interest.  Until  re- 
cently his  claims  were  disregarded.  Existing  investments  could  be 


STATE  REGULATION  OF  SECURITIES  27 

submitted  to  any  number  of  burdens  without  the  possibility  of 
escape.  The  holder  of  free  funds,  however,  notes  all  such  tendencies 
and  is  quick  to  divert  his  money  into  more  promising  channels. 
With  a  dull  market  for  railroad  or  other  public  utility  offerings,  the 
public  fails  to  acquire  needed  facilities,  and  is  thus  impressed  with 
the  justness  of  the  investors'  claims. 

The  public  itself  is  most  directly  benefited  by  security  control. 
It  is  often  asserted  that  securities  have  no  bearing  upon  rates,  and 
commissions  declare  that  they  do  not  take  them  into  account. 
But  a  careful  investigation  of  the  proceedings  of  any  commission 
will  reveal  instances  in  which  the  rate  was  based  upon  the  condition 
of  the  corporation's  securities.  Always  a  return  is  insisted  upon. 
"It  is  the  setting  in  which  the  problem  (of  rates)  is  most  frequently 
submitted  for  judicial  consideration,"  the  Interstate  Commerce 
Commission  has  declared.94  Aside  from  rates,  every  reorganization, 
the  direct  product  of  unwise  security  issues,  upsets  the  business 
equilibrium  of  the  entire  country.  Unwise  security  issues  also  react 
to  the  detriment  of  the  public  by  poorer  service,  inadequate  main- 
tenance and  depreciated  equipment. 

Present  regulation  does  not  solve  the  problem  of  proper  security 
control,  yet  some  regulation  is  expedient.  The  first  step  needed  to 
clarify  the  situation  is  to  distinguish  between  corporations  that  are 
interstate  and  those  which  are  intrastate  or  local  in  character. 
Railroads  and  corporations  controlling  facilities  essential  to  the 
efficient  operation  of  the  railroads  are  of  chief  interest  in  the  first 
class,  but  whatever  corporations  are  placed  under  the  control  of  the 
Interstate  Commerce  Commission  should  be  included.  A  rail- 
road's securities  are  the  sine  qua  non  of  its  establishment  and  exten- 
sion, are  co-existent  with  each  foot  of  its  line,  and  cry  out  for  uni- 
form treatment,  possible  solely  through  national  control.  More 
detailed  consideration  of  federal  control  is  not  required  here,  except 
to  remark  that  the  securities  of  interstate  corporations  should  be 
placed  under  the  sole  and  exclusive  control  of  a  central  federal  body, 
an  adjunct  of  the  Interstate  Commerce  Commission,  and  forming  a 
part  of  a  rational  scheme  of  complete  federal  regulation. 

Federal  regulation  of  only  interstate  corporations  leaves  a  very 
wide  field  to  the  states.  Light,  heat  and  water  companies  and 
street  railways  are  a  few  of  the  corporations  whose  securities  should 

94  Interstate  Commerce  Commission,  22d  Annual  Report,  p.  86. 


28  SUMMARY  AND  CONCLUSION 

be  regulated  by  state  commissions.  Appointment  to  such  com- 
missions should  have  some  more  efficient  base  than  political  prestige. 
Commission  control  should  be  positive,  for  there  is  no  need  to 
regulate  the  well  managed  corporation,  and  the  fear  of  publicity 
will  prove  inadequate  to  prevent  the  unscrupulous  from  enriching 
themselves. 

The  bread  pill  stage  of  regulation  must  be  put  behind,  whether 
the  regulation  is  to  be  by  state  or  federal  commissions.  Thorough 
investigation  and  valuation  should  be  made  before  approval  is 
granted.  Restrictions  should  be  placed  upon  the  power  of  the 
commission  as  well  as  upon  the  corporation.  It  should  be  unlawful 
for  the  commission  to  authorize  issues  far  in  excess  of  the  value  of  the 
property.  There  is  no  reason  for  the  commission  to  decide  the  kind 
of  security,  except  to  prevent  an  unsafe  proportion  of  debts  to  owner- 
ship shares.  Supervisory  power  over  prices  is  sufficient,  although  a 
minimum  price  for  bonds  and  no  par  for  stock  might  add  efficiency 
to  the  legislation.  The  duty  of  the  commission  to  follow  up  the 
disposition  of  the  proceeds  from  the  sale  of  securities  is  no  less  im- 
portant than  the  approval  itself.  Finally,  uniformity  is  desirable 
for  all  security  legislation,  since  the  investment  market  is  national. 

The  beneficial  results  of  the  right  kind  of  legislation  are  in- 
calculable. No  legislation  causes  a  haphazard,  mushroom  growth. 
Irrational  legislation  destroys  the  fine  network  of  confidence  with- 
out which  the  inflow  of  funds  will  soon  cease  and  development  come 
to  a  standstill.  Rational  legislation  instills  confidence,  so  that  the 
full  complement  of  needed  funds  is  secured  quickly  and  cheaply. 


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